Section 501(c)(4) and the Social Welfare Organization

The article highlighted the family’s longstanding commitment to charitable causes, and the lack of tax benefits, including a charitable deduction, associated with the transfer. The Patagonia story garnered significant national attention and spurred advisors and charitably inclined clients to ask reasonable questions: What is a 501(c)(4)? How are they different from more familiar charitable organizations? Are there reasons to consider 501(c)(4)s within our own wealth and charitable plans, particularly if there is no apparent tax benefit? What follows is a brief summary of characteristics of 501(c)(4) organizations, what distinguishes them from more familiar charitable structures, notable features of their organization and operation, and the tax and non-tax benefits they may provide.

Introduction to Social Welfare Organizations Under IRC § 501(c)(4)

The Internal Revenue Code (IRC) provides exemption from taxation for certain organizations, including those described in § 501(c)(4).[1] Section 501(c)(4) describes two types of exempt organizations: (1) those that are organized for the promotion of social welfare and (2) local associations of employees.[2] A social welfare organization qualifies for tax exemption so long as (1) it does not operate for profit, (2) it operates exclusively for the promotion of “social welfare,” and (3) none of the organization’s net earnings inure to the benefit of any private shareholder or individual.[3] Organizations that operate to promote social welfare are “primarily engaged in promoting in some way the common good and general welfare of the people of the community,” with the “purpose of bringing about civic betterments and social improvements.”[4] Social welfare activities also include charitable activities that can be conducted by Section 501(c)(3) organizations (discussed below).  

Social welfare organizations may engage in unlimited lobbying activity so long as such lobbying efforts are germane to their exempt purposes and are in furtherance of the common good rather than private gain.[5] While “promotion of social welfare,” does not include political campaign activities, social welfare organizations are permitted to engage in some political campaign activities on a limited basis. Such activities must not be a substantial part of their activities when combined with all other non-social welfare activities.[6]

Charitable Organizations Under IRC § 501(c)(3)

Most people are more familiar with Section 501(c)(3) organizations. Organizations that meet the requirements of § 501(c)(3) are exempt from federal income tax as charitable organizations, and contributions made to charitable organizations by individuals and corporations are deductible for income tax purposes under § 170. A “charitable organization” for this purpose is organized and operated “exclusively for religious, charitable, scientific, testing for public safety, literary or educational purposes, or to foster national or international amateur sports competition… or for the prevention of cruelty to children of animals.”[7]

Charitable organizations are classified as either public charities or private foundations.[8] Generally, charitable organizations that are classified as public charities are those that (1) are churches, schools, colleges and universities, hospitals, and medical research organizations affiliated with hospitals, (2) have an active program of fundraising and receive contributions from many sources, (3) receive income from the conduct of activities in furtherance of its exempt purposes, or (4) actively function in a supporting relationship to one or more existing public charities.[9]

Private foundations on the other hand are charitable organizations that are typically funded by a single source or just a handful of donors, often from among a single family. Private foundations may be engaged in grant-making programs in support of charitable endeavors or may actively conduct charitable programs. Private foundations are subject to more restrictive rules than public charities and are subject to a number of excise taxes that operate as guideposts for foundation operations and activities, including mandatory income distributions.[10]

Differentiating Social Welfare Organizations From Charitable Organizations

Social welfare organizations are, operationally, more flexible than charitable organizations; they can engage in all activities of a charitable organization, as well as additional activities that would be impermissible for 501(c)(3)s. The most distinctive features of social welfare organizations are their ability to engage in unlimited lobbying activity and limited political campaign activity. They can also be funded by a single donor or just a small amount of donors but are not subject to the excise taxes that apply to private foundations. This broadened scope of permissible activities and flexibility in funding afforded to social welfare organizations is a key distinction in evaluating their utility as a charitable or philanthropic tool.

The deductibility of contributions by donors is another critical distinction. Contributions to 501(c)(3) charitable organizations are deductible for income tax purposes (though they may be subject to specified limitations).[11] Generally, an estate tax deduction is similarly available for assets transferred to qualified charitable organizations on death, as is a corresponding unlimited gift tax deduction for gratuitous lifetime transfers.[12] Contributions to social welfare organizations are not as robustly tax-incented, most notably because they are not deductible for income or estate tax purposes. However, lifetime transfers to social welfare organizations are not subject to gift tax and thus can effectively reduce a donor’s taxable estate without incurring gift tax or gift tax reporting obligations.[13] Lifetime transfers to social welfare organizations also do not trigger generation-skipping transfer (GST) tax implications because social welfare organizations are assigned to the transferor’s generation for GST purposes. Additionally, as with Section 501(c)(3) organizations, donors to social welfare organizations are not required to recognize gain on contributions of certain types of appreciated assets.

For owners of closely held business interests, social welfare organizations present an additional planning opportunity unavailable in the private foundation context. Unlike private foundations, social welfare organizations are not subject to stringent excess business holdings limitations. The excess business holdings rules generally limit the stock holdings of private foundations and certain associated persons to 20% of a corporation’s voting stock reduced by the percentage of voting stock actually or constructively owned by all “disqualified persons.”[14] Because social welfare organizations are not subject to an excess business holdings threshold, the funding, structure, and ongoing management of the organization is less onerous when compared to private foundations subject to this limitation.

Social welfare organizations can also provide donors an increased level of privacy with respect to donor disclosure. IRS Form 990, Schedule B lists the donor’s name, address, and contribution for donations exceeding $5,000. Private foundations are required to file Form 990-PF, disclose the requisite donor information, and make Form 990-PF (including Schedule B) available for public inspection. Public charities file a Form 990 and are required to disclose certain donor information to the IRS on Schedule B, although they are not required to make the Schedule B available for public inspection. Social welfare organizations are also not required to publicly disclose their donors. While a social welfare organization’s Form 990 is publicly available, Schedule B is excluded as with public charities, providing donors with a unique layer of privacy unavailable through private foundations.

Individual circumstances will always play an important role in the evaluation of exempt organizations and how they might facilitate charitable goals. The balance must be sought between the tax advantages afforded by charitable organizations and the flexibility afforded by social welfare organizations. Patagonia provides just a single example of how the expanded activities provided through social welfare organizations can prove more valuable than foregone tax benefits for a prospective donor’s charitable goals and intentions. Clients and advisors alike should be aware that social welfare organizations exist as an option and have been successfully utilized for such purposes for some time, even if they are only now receiving more public recognition as both viable and valuable planning tools.

[1] IRC § 501(a).

[2] IRC § 501(c)(4).

[3] IRC § 501(c)(4)(A)-(B).

[4] Treas. Reg. § 1.501(c)(4)-1(a)(2)(i).

[5] See Treas. Reg. § 1.501(c)(4)-1(a)(2)(i); See also Treas. Reg. § 1.501(c)(3)-1(c)(3).

[6] See Treas. Reg. § 1.501(c)(4)-1(a)(2)(ii); Rev. Rul. 81-95, 1981 C.B. 332.

[7] See IRC § 501(c)(3).

[8] See IRC § 509(a)

[9] Id.

[10] See IRC §§ 4940-4945

[11] See IRC § 170(a)-(b); IRC § 170(c)(2).

[12] IRC § 2055(a)(2); IRC § 2522(a)(2).

[13] IRC § 2501(a)(6). It should be noted, however, that transfers to social welfare organizations upon death are neither deductible, nor exempt, for estate tax purposes.

[14] IRC § 4943(c)(2)(C).